Fashion brands from Hong Kong, Europe and the United States could gain from a possible free-trade agreement between Sri Lanka and mainland China that would remove all tariffs on goods from the island nation.

Sri Lanka, whose earnings from garments account for half of its entire industrial output, has long been a manufacturing hub for upmarket lingerie, T-shirts and blouses. The country is the largest supplier for Victoria's Secret and an important manufacturing hub for Gap, Marks and Spencer and other European brands.

"International brands could win big shipping their products from Sri Lanka to China if the free-trade deal is reached," said Ashroff Omar, chief executive of Brandix, Sri Lanka's largest apparel exporter.

If the free-trade deal materialises, all textile products from Sri Lanka would be exempt from tariffs, which currently range from 14 per cent to 25 per cent, depending on the product type. Under a previous preferential trade agreement between eight countries in the Asia-Pacific region, garment products from Sri Lanka enjoyed a discount of 3 to 5 per cent.

Sri Lanka's central bank governor Ajith Nivard Cabraal said the free-trade talks could be completed by next year.

"Formal discussion between the new Chinese president and our president began three months ago. The idea is that we will enter into a regional agreement. Officials are still working on the details but we believe it will happen reasonably quickly, perhaps by early next year," he said.

Sri Lanka, which already has a free-trade deal with India and Pakistan, is pinning its hopes on a new trade pact with China to breathe life into its US$59 billion economy after a 26-year-old civil war ended in 2009.

The talks come at a time when rising wages and shortage of labour in China weigh on manufacturers, driving up their operating costs and forcing them to look elsewhere to relocate their production lines.

Cabraal said it is too early to say if China will surpass India to become Sri Lanka's biggest trading partner following the agreement, but added such a deal would have a significant impact on the two countries' trade relations.

Chinese companies, both state-owned and private, have spent billions of dollars building power plants, ports and highways in Sri Lanka.

Omar said the operating cost - including labour, utilities and rental costs - of running a garment factory in Sri Lanka is US$1 an hour, compared with at least US$2 per hour in China. The unit cost in Sri Lanka is on a par with that in India, but a little lower than costs in Vietnam and Indonesia.

Omar is looking to persuade Hong Kong fashion retailers to outsource their production to Sri Lanka. Hong Kong-based Esquel Enterprises, the world's leading producer of upmarket cotton shirts, has already set up production plants in four cities in Sri Lanka. It has more than 30 clients, including Abercrombie & Fitch, Esprit, Giordano, Marks and Spencer and Muji.

"We are pretty excited about the talks so far and I have been told [by officials] that the deal is on a fast track," Omar said.

"China doesn't yet have Sri Lanka as an important trade partner but it will surely do so after the free-trade agreement," said Sirimal Abeyratne, professor of economics at the University of Colombo.

Sri Lankan exports to China have much room to increase since China is ranked a relatively low 16th among the island nation's export destinations, according to Central Bank of Sri Lanka data. China, on the other hand, has become the country's second-largest source of imports, after India.

The top five Sri Lankan merchandise imports into China are natural fibres, tea, rubber, ores, textiles and garments.

Beijing is pressing hard to reinforce its trade ties with Southeast Asia and South Asia. On top of the China-Asean free-trade agreement, China has established free-trade relations with Singapore and Pakistan. Meanwhile, China and India are studying the possibility of a regional trade agreement, according to the Ministry of Commerce website.

"Sri Lanka should look beyond India as it has been too reliant on India in a wide spectrum, from tourism to financial sector and foreign investment to exports," said Abeyratne. "China has great potential to be a good market for Sri Lanka."

This article appeared in the South China Morning Post print edition as China eyes Sri Lankan free-trade deal